3.6.2008economics of climate change1 chapter 14 harnessing markets for mitigation - the role of...

3.6.2008 Economics of Climate Change 1

Chapter 14Chapter 14

Harnessing Markets for Mitigation -Harnessing Markets for Mitigation -the role of taxation and tradingthe role of taxation and trading

Sari Karvonen, Katri OksanenSari Karvonen, Katri Oksanen

3.6.2008 2Economics of Climate Change

OverviewOverview

• The key features of greenhouse-gas externalityThe key features of greenhouse-gas externality• Standart theory of externalitiesStandart theory of externalities• Efficient carbon reductionEfficient carbon reduction• Prices versus quantity in the short term and long Prices versus quantity in the short term and long

termterm• Setting short term policy to meet long term goalsSetting short term policy to meet long term goals• The social cost of carbon and the carbon priceThe social cost of carbon and the carbon price• ConclusionConclusion


The key features of greenhouse-gas The key features of greenhouse-gas externalityexternality

• A global externalityA global externality• impacts are not immidiately tangibleimpacts are not immidiately tangible• uncertainty around the scale and timinguncertainty around the scale and timing• the effects are potentially on a massive the effects are potentially on a massive

scalescale


Standard theory of externalities:Standard theory of externalities:

1) a tax can be introduced so that the emitters 1) a tax can be introduced so that the emitters face the full social cost of their emissionsface the full social cost of their emissions

2) quantity restrictions can limit the volume 2) quantity restrictions can limit the volume of emissionsof emissions

3) a full set of property rights can be allocated3) a full set of property rights can be allocated4) a single organisation can be created which 4) a single organisation can be created which

brings those causing the externality together brings those causing the externality together with all those affectedwith all those affected


• The key aim of climate-change policy should be to The key aim of climate-change policy should be to ensure that those generating GHG’s face the ensure that those generating GHG’s face the marginal cost of emissions that reflects the marginal cost of emissions that reflects the damage they causedamage they cause

-> encourages emitters to invest in alternative, low -> encourages emitters to invest in alternative, low carbon technologies, and consumers of GHG-carbon technologies, and consumers of GHG-intensive goods and services to change their intensive goods and services to change their spending patterns in response to an increase in spending patterns in response to an increase in relative pricesrelative prices


Efficient carbon reduction:Efficient carbon reduction:

• Two conditions must hold to reduce GHG Two conditions must hold to reduce GHG emissions efficiently:emissions efficiently:

1)1) Abatement should take place up to the point Abatement should take place up to the point where the benefits of further emissions where the benefits of further emissions reductions are just balanced by the costsreductions are just balanced by the costs

(social cost of carbon= marginal cost of abatement)(social cost of carbon= marginal cost of abatement)

2) To deliver reductions at the lowest cost, a 2) To deliver reductions at the lowest cost, a common price signal is required across countriescommon price signal is required across countries


Prices versus quantity in the short Prices versus quantity in the short term and long termterm and long term

• A) The efficiency of taxes and tradable allowances A) The efficiency of taxes and tradable allowances in climate-change mitigation in the short termin climate-change mitigation in the short term


Prices versus quantities in the short Prices versus quantities in the short term and long termterm and long term

• B) The efficiency B) The efficiency of taxes and of taxes and tradable allowance tradable allowance in climate-change in climate-change mitigation in the mitigation in the long termlong term


Efficiency under uncertaintyEfficiency under uncertainty

Weizman (1974) examined how the price and quota of Weizman (1974) examined how the price and quota of quantity control instruments compare where there is quantity control instruments compare where there is uncertainty about the cost and benefits of actionuncertainty about the cost and benefits of action

Applying the Weitzman analysis to pollution:Applying the Weitzman analysis to pollution:• Prices are preferable when the benefits of reducing Prices are preferable when the benefits of reducing

pollution outweigh the costs, for example shown in the pollution outweigh the costs, for example shown in the graph. This applies to quantity controls as well.graph. This applies to quantity controls as well.

• However, at a given level of pollution, the costs could However, at a given level of pollution, the costs could exceed the benefitsexceed the benefits


These characteristics of costs and damage benefits of These characteristics of costs and damage benefits of abatement and damage from emission suggest three abatement and damage from emission suggest three things:things:

• Policy instruments should distinguish between the Policy instruments should distinguish between the short-term and long-termshort-term and long-term

• clear long-term goalsclear long-term goals• In the short term,the policy-maker will want to In the short term,the policy-maker will want to

choose a flexible approach to achieving long term choose a flexible approach to achieving long term goalsgoals


Setting short term policy to meet Setting short term policy to meet long term goalslong term goals

Aspects:Aspects:• The price of carbon is likely to rise over timeThe price of carbon is likely to rise over time• short-term tax or trading policies will then need to short-term tax or trading policies will then need to

be consistentbe consistent• In tax-based regime, the tax should be set to In tax-based regime, the tax should be set to

reflect to marginal damage caused by emissionsreflect to marginal damage caused by emissions• In tradable quota scheme, the parameters of the In tradable quota scheme, the parameters of the

scheme should be set with a view to generating a scheme should be set with a view to generating a market price that is consistent with the social cost market price that is consistent with the social cost of carbonof carbon


The social cost of carbon and the The social cost of carbon and the carbon pricecarbon price


The stabilasation target is analogous to the inflation target.The stabilasation target is analogous to the inflation target.However, the analogy is not exact:However, the analogy is not exact:1)1) There is not yet agreement about the stabilisation level at There is not yet agreement about the stabilisation level at

which stability should achievedwhich stability should achieved2)2) The stabilitization objective is likely to be revised The stabilitization objective is likely to be revised

intermittently to reflect improved scientific and economic intermittently to reflect improved scientific and economic undestanding of climate-change problemsundestanding of climate-change problems

3)3) The locus of decision- making in monetary policy clearly The locus of decision- making in monetary policy clearly lies with the monetary authority of the country for which lies with the monetary authority of the country for which the inflation rate is measuredthe inflation rate is measured


Public finance issuesPublic finance issues

This transfer may be used to:This transfer may be used to:• enhance the revenue baseenhance the revenue base• limit the overall tax burden on the industry limit the overall tax burden on the industry

affected through revenue recyclingaffected through revenue recycling• reduce taxes elsewhere in the economyreduce taxes elsewhere in the economy


The strengths of the carbon taxes:The strengths of the carbon taxes:• can contribute to establishing a consistent price can contribute to establishing a consistent price

signal across regions and sectorssignal across regions and sectors• raise public revenuesraise public revenues• can be kept stable and thus do not risk fluctuations can be kept stable and thus do not risk fluctuations

in the marginal cost that could increase the total in the marginal cost that could increase the total cost of mitigation policycost of mitigation policy

However, they do not automatically generate financial However, they do not automatically generate financial flows to developing countries in search of the most flows to developing countries in search of the most effective carbon reductionseffective carbon reductions


The strengths of tradable quotas:The strengths of tradable quotas:• the extent that the scheme embraces the extent that the scheme embraces

different sectors and countriesdifferent sectors and countries• the extent that inter country trading is the extent that inter country trading is

allowedallowed• if allowances are sold or auctioned, then the if allowances are sold or auctioned, then the

scheme also has the potential to genarate scheme also has the potential to genarate public revenuespublic revenues


ConclusionConclusion

At the international level, this means that the key At the international level, this means that the key policy objectives for tackling climate change policy objectives for tackling climate change should include chosing a policy regime:should include chosing a policy regime:

• in the long term will stabilise the GHG in the in the long term will stabilise the GHG in the atmosphereatmosphere

• in the short term use a price signal (tax or trading) in the short term use a price signal (tax or trading) to drive emission reductionto drive emission reduction

• Establishing a consistent price signal across Establishing a consistent price signal across countries and sectors to reduce GHG emissionscountries and sectors to reduce GHG emissions

3.6.2008 Economics of Climate Change 18

Chapter 18Chapter 18

Understanding the Economics of Understanding the Economics of AdaptationAdaptation

Sari Karvonen, Katri OksanenSari Karvonen, Katri Oksanen


ContentsContents

• Role of adaptationRole of adaptation• Adaptation perspectivesAdaptation perspectives• Barriers and limits to adaptationBarriers and limits to adaptation• ConclusionsConclusions


Role of adaptationRole of adaptation

• What is adaptation?What is adaptation?

””Any adjustment in natural or human systems Any adjustment in natural or human systems in response to actual or expected climatic in response to actual or expected climatic stimuli or their effects, which moderates stimuli or their effects, which moderates harm or exploits beneficial opportunities.”harm or exploits beneficial opportunities.”

Intergovernmental Panel on Climate Change IPCC (2001)Intergovernmental Panel on Climate Change IPCC (2001)


• An essential part of a response to the An essential part of a response to the challenge of climate changechallenge of climate change

crucial and only way to deal with the crucial and only way to deal with the unavoidable effects of climate changeunavoidable effects of climate change

offers an opportunity to adjust economic offers an opportunity to adjust economic activity in vulnerable sectors and activity in vulnerable sectors and support sustainable developmentsupport sustainable development


• Objective: to reduce vulnerability to Objective: to reduce vulnerability to climatic change and variability climatic change and variability reduces their negative impactsreduces their negative impacts enhances the capability to capture enhances the capability to capture any any benefits of climate changebenefits of climate change

Thus adaptation together with mitigation is an Thus adaptation together with mitigation is an important response strategy!important response strategy!


The role of adaptation in reducing climate change damages

The Stern Review page 405 Figure 18.1


Adaptation perspectivesAdaptation perspectives

• Two adaptation perspectives:Two adaptation perspectives: Autonomous: actions that are taken Autonomous: actions that are taken naturally by private actors without any naturally by private actors without any active active intervention of policyintervention of policy Policy-driven: adaptation a result of a Policy-driven: adaptation a result of a deliberate policy decisiondeliberate policy decision

• The need for policy-driven adaptation is defined The need for policy-driven adaptation is defined by the extent to which society can rely on by the extent to which society can rely on autonomous adaptationautonomous adaptation


Examples of adaptation in practice

The Stern Review page 406 Table 18.1


• Difference between short-run and long-run Difference between short-run and long-run adaptation decisionsadaptation decisions

Basic diagram:Basic diagram:

K x E

The Stern Review page 408 Box 18.1


• In the short runIn the short run

responding only by changing variable responding only by changing variable inputsinputs


Change in E due to climatic change and variability over a short period of time


• In the long runIn the long run

responding by changing both variable responding by changing both variable inputs and the capital stockinputs and the capital stock


Change in E due to climatic change and variability over a long period of time


• In practise adaptation occurs in response to In practise adaptation occurs in response to particular climate events and in context of particular climate events and in context of other socio-economic changesother socio-economic changes

• First step of adaptationFirst step of adaptation

responding to changed climate and responding to changed climate and weatherweather

• Second step of adaptationSecond step of adaptation

enhancing these responses to prepare for enhancing these responses to prepare for future impactsfuture impacts


• Many decisions made autonomouslyMany decisions made autonomously

important consequences for the way important consequences for the way economists understand and appraise economists understand and appraise

adaptation policyadaptation policy

1) much adaptation will be triggered 1) much adaptation will be triggered by by the way climate change is experiencedthe way climate change is experienced

2) many adaptation decisions involve 2) many adaptation decisions involve a a measure of habit and custommeasure of habit and custom


• Decisions about the timing and amount of Decisions about the timing and amount of adaptation require that costs and benefits adaptation require that costs and benefits are compared are compared

the chosen route should be the one with the chosen route should be the one with the highest net benefit while the risks the highest net benefit while the risks and uncertainties of climate change and uncertainties of climate change

have have been taken into accountbeen taken into account


Adaptation costs and benefitsAdaptation costs and benefits

TT00: without climate change: without climate change AA00: Without climate change: Without climate change

TT11: with climate change: with climate change AA11: With climate change: With climate change

• Climate change damage: W(TClimate change damage: W(T11, A, A00) – W(T) – W(T00, A, A00))• Net benefits of adaptation: W(TNet benefits of adaptation: W(T11,A,A11) – W(T) – W(T11, A, A00))• Climate change damage after adaptation: W(TClimate change damage after adaptation: W(T11, A, A11) – W(T) – W(T00, A, A00))



The trade-offs of planning adaptation under uncertainty

When deciding which adaptation strategy to implement, the balance of risks and costs of planning for climate change that do not occur (and vice versa) should be take into account



• Not a lot of studies where adaptation costs Not a lot of studies where adaptation costs and benefits are reported separatelyand benefits are reported separately

• However some studies have been made for However some studies have been made for sectors especially vulnerable to climate sectors especially vulnerable to climate changechange

coastal protectioncoastal protection

agricultureagriculture


The Stern Review page 411 Table 18.2


Barriers and limits to adaptationBarriers and limits to adaptation

• Autonomous adaptation unlikely to lead to Autonomous adaptation unlikely to lead to efficient adaptation becauseefficient adaptation because

1) uncertainty and imperfect information1) uncertainty and imperfect information

2) missing and misaligned markets2) missing and misaligned markets

3) financial constraints.3) financial constraints.

the barriers of adaptationthe barriers of adaptation


1) Uncertainty and imperfect information1) Uncertainty and imperfect information

- high-quality information on future - high-quality information on future climate change is importantclimate change is important

- determined understanding about the - determined understanding about the likely consequences of climate change likely consequences of climate change

uncertainty acts as a significant uncertainty acts as a significant disadvantage to adaptationdisadvantage to adaptation


2) Missing and misaligned markets2) Missing and misaligned markets- Autonomous adaptation is more likely in - Autonomous adaptation is more likely in the short-run when the benefits pile up to the short-run when the benefits pile up to those investing in adaptation those investing in adaptation - In the long-run effective adaptation may - In the long-run effective adaptation may be challenging to private markets be challenging to private markets uncertain future benefits vs. most certain uncertain future benefits vs. most certain current costscurrent costs also those who didn’t share the costs are also those who didn’t share the costs are going to benefitgoing to benefit


3) Financial constraints3) Financial constraints

- the poorest in society have the least capacity to - the poorest in society have the least capacity to adaptadapt

the impacts of climate change could the impacts of climate change could exacerbate existing inequalitiesexacerbate existing inequalities

Limits of adaptationLimits of adaptation

1)1) residual uncertaintyresidual uncertainty

2)2) natural limitsnatural limits

3)3) technical limitstechnical limits


ConclusionsConclusions

• Many ways to adapt both autonomously and Many ways to adapt both autonomously and through policiesthrough policies

• Governments have to support autonomous Governments have to support autonomous adaptationadaptation

• Adaptation can mute the impacts, but it can Adaptation can mute the impacts, but it can not solve the problem of climate change not solve the problem of climate change limitslimits


QuestionsQuestions


1) In the standard theory of externalities, there 1) In the standard theory of externalities, there are four ways in which negative are four ways in which negative externalities can be approached. Which one externalities can be approached. Which one is the best way? Can you imagine any other is the best way? Can you imagine any other ways to reduce negative externalities?ways to reduce negative externalities?


2) Is it fair, that if marginal cost of reduction 2) Is it fair, that if marginal cost of reduction is lower in country A than in country B, is lower in country A than in country B, then abatement costs could be reduced by then abatement costs could be reduced by doing a little more reduction in country A doing a little more reduction in country A and a little less in country B? How we can and a little less in country B? How we can reduce emissions efficiently? Why is reduce emissions efficiently? Why is emission reducing so problematic?emission reducing so problematic?


3) What kind of short-term policy should we 3) What kind of short-term policy should we use to achieve long-term stabilisation goals? use to achieve long-term stabilisation goals? What problems can arise?What problems can arise?


4) Revenue recycling to the industry can 4) Revenue recycling to the industry can encourage emitters to reduce GHG encourage emitters to reduce GHG emissions, without increasing their overall emissions, without increasing their overall tax burden relative to other parts of the tax burden relative to other parts of the economy. What are the advantages and economy. What are the advantages and disadvantages of this approach?disadvantages of this approach?


5) Why is adaptation so important? Couldn’t 5) Why is adaptation so important? Couldn’t we just rely on mitigation?we just rely on mitigation?


6) There are two adaptation perspectives, an 6) There are two adaptation perspectives, an autonomous and a policy-driven response to autonomous and a policy-driven response to climate change. What are the characteristics climate change. What are the characteristics of them and would the use of autonomous of them and would the use of autonomous adaptation in itself be sufficient enough?adaptation in itself be sufficient enough?


7) In which areas is it indicated that efficient 7) In which areas is it indicated that efficient adaptation might reduce climate damages adaptation might reduce climate damages significantly and why is that?significantly and why is that?


8) Why are both mitigation and adaptation 8) Why are both mitigation and adaptation important?important?

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